Aug. 30 (Bloomberg) -- European policy makers end August
with 15 days to justify bondholder optimism that they can
deliver lasting solutions to the debt turmoil.

September offers a microcosm of three years of crisis-fighting. The next two weeks may feature fresh anti-contagion
measures from the European Central Bank, a possible aid request
from Spain and insight into whether creditors will ease Greece’s
bailout terms. German judges and Dutch voters also get to
proclaim on the euro’s future.

At stake is whether politicians and the ECB can extend a
summertime shift in borrowing costs by convincing investors
Spain and Italy are protected from the rot and the euro is
secure. Since ECB President Mario Draghi’s July 26 vow to do
“whatever it takes” to defend the currency, Spain’s 10-year
bond yield has fallen about half a point to 6.52 percent, while
that of Italy has declined by a quarter-point to 5.81 percent.

“The markets seem to be anticipating progress,” said
Mickey Levy, chief economist at Bank of America Corp. in New
York. “When you talk to European policy makers, they say we’re
entering a very important stage.”

The month’s main event comes Sept. 6 when Draghi convenes
his Governing Council, after declaring Aug. 2 it’s
“unacceptable” for investors to bet against the euro’s future
by elevating bond yields. Draghi said that may spur the ECB to
buy short-dated bonds in the secondary market, albeit only in
concert with direct purchases from governments by Europe’s
rescue fund, with accompanying economic conditions.

Buying Bonds

“Unlimited intervention by the ECB in the bond markets
would be the ultimate game-changer in the euro zone debt
crisis,” said Steven Major, global head of fixed income
research at HSBC Holdings Plc in London. “Not only would it
drive spreads down, it would keep them down.”

Keeping the yields of peripheral nations within a preset
range of those of core economies could require the ECB to spend
as much as 7 billion euros ($8.8 billion) per week buying bonds,
Major estimates. The gap between two-year German and Spanish
bonds could almost halve to 200 basis points from more than 370
currently, he said.

The ECB “will always act within the limits of its
mandate,” Draghi wrote in a commentary for German newspaper Die
Zeit provided by the Frankfurt-based ECB yesterday. “Yet it
should be understood that fulfilling our mandate sometimes
requires us to go beyond standard monetary policy tools.”

Steering Yields

While speculation has mounted the central bank may try to
cap bond yields outright, Goldman Sachs Group Inc. economist Huw
Pill predicts it will avoid explicit targets for rates or
spreads and instead try to steer market yields within wider
bands depending on economic performance.

The central bankers may even hold fire. ECB Executive Board
member Joerg Asmussen said Aug. 27 that the bank shouldn’t buy
bonds before the rescue fund intervenes. Two officials said last
week it may even hold off furnishing full details of its plan
until Germany’s Constitutional Court rules on the legality of
the European Stability Mechanism.

So Sept. 12 provides investors with two flashpoints, the
German court ruling and a Dutch election. The ESM cannot operate
without Germany’s say so and its 500 billion-euro cash pile is
needed if Europe is to have enough cash to recapitalize banks
and support Spain and Italy.

‘Euro-Skepticism’

Joachim Fels, the chief economist at Morgan Stanley in
London, says even if the court sanctions the ESM, it may attach
conditions which limit the German government’s ability to pursue
deeper European integration in the future. “Given the rise of
euro-skepticism in Germany and elsewhere, markets would likely
take such a verdict by the court as a bad sign,” he said.

Jostling for investors’ focus the same day is the
Netherlands election. In polls, a third of voters back the
Socialists, who oppose more spending cuts and refuse to hand
over more sovereignty to Europe, or the Freedom Party, which
seeks an exit from the European Union and the single currency.
It could take months for a coalition to be formed.

European finance ministers will meet Sept. 14-15 in Cyprus
with Greece, Europe’s original problem child, still under the
microscope. After two bailouts totaling 240 billion euros, the
nation is struggling to qualify for the next instalment, raising
the risk of a second default and even a possible euro exit.

With his economy plagued by an austerity-driven fifth year
of recession, Prime Minister Antonis Samaras wants more time to
meet the rescue terms. Possible concessions floated in Germany
include front-loading aid, lowering the interest rate or
extending maturities on loans and extending debt writedowns to
public holdings such as the ECB’s.

Survival Time

The so-called troika -- the ECB, European Commission and
IMF -- return to Athens early next month to study how much of a
funding shortfall Greece faces. While asking for an extension in
its fiscal adjustment program by two years to 2016, the
government is trying to show its dedication to the troika’s
demands by pulling together a new package of spending cuts for
the next two years.

“With some German flexibility, Greece may survive this
September,” said Christian Schulz, an economist at Berenberg
Bank in London, who reckons the probability of a Greek euro exit
has eased to 35 percent from almost 50 percent earlier this
month. “But the pressure remains on Greece to take ownership of
the reforms and deliver results.”

ECB Faith

Economists at Citigroup Inc. are less confident, saying
last week they view a Greek departure in the next six months as
“increasingly likely” and possible as soon as next month
should the troika decide the government hasn’t done enough. A
decision on whether Greece needs more aid may still not come
before October, Luxembourg Prime Minister Jean-Claude Juncker
said last week.

The Cyprus talks will also review a first slate of European
Commission proposals to forge a euro region banking union, with
common supervision for lenders and pooled funds to deal with
crises. The plans, which the Brussels-based commission has
earmarked for publication on Sept. 11, include a draft law to
hand supervisory powers to the European Central Bank, a
refurbishment of the European Banking Authority and a policy
paper setting out the rest of the banking union project.

Euro area leaders said in June that legislators should
study the supervisory plans “as a matter of urgency.” The
commission’s intention is that they would enter into force in
early 2013.

Investors may be placing too much faith in the ECB and in
the ability of governments to soothe their fiscal stresses in a
17-nation bloc still lacking economic union, said Neil Williams,
head of economic research at Hermes Fund Managers in London,
which oversees about $46 billion.

“There’s a bit too much optimism that the euro zone can
solve itself in September,” said Williams. “This is going drag
into next year and beyond.”